Wednesday, June 25, 2008

Fed stands pat:..surprise, like the sun coming up

Ignore that man behind the curtain...ignore him I say...Let's get kooky. Let's ask WHY the Fed has a statement after each meeting. IF we can figure that out it will be easier to understand what they are saying in the statement. FED as Aristotle or as Uncle Remus?

Ostensibly the Fed is trying to help us to understand what it is doing through a systematic method of scientific discovery so we can understand how it sees the policy risks. But talk to any Fed guy/gal and they first thing they will say is how 17 people write that statement-thing and how hard it is to get agreement on it (17 when the Fed is fully staffed, of course). So the Fed may not be teaching us as much as it is telling us a story...and leaving us to our own personal brier patches. Tripping over its own 34 feetYou have undoubtedly noticed that what happens after each Fed meeting is that the Fed does NOT write a new statement. It takes the previous one and tortures it ever so slightly to carry a fresh nuance. It does this because it is too hard to make more sweeping changes with 34 hands editing it and 34 eyes sweeping over each edit.Zipitty do-dahSo in the end we can conclude that while the Fed began by writing a statement to give US guidance, the Fed actually does not force a consensus view on members so it can write a clear statement of policy and of the Fed's perceived risks. It writes instead from the point of view of collective disagreement. So what the statement reveals is what members disagree about the least. There is probably something for everybody hidden in the prose of that densely worded little post-meeting nugget...of fool's gold.Consensus lost, pair-a-dice gained The statement does not reflect what the Fed 'thinks' since the Fed has not forced any consensus on its members to think any particular way. Instead, it reflects the breadth of issues various members are concerned about. For some it's inflation or inflation expectations. For others it is economic weakness. And sometimes one view seems to hold sway over the others but rarely is a Fed statement crisp, clear and to only one point. This June statement is a perfect example of that. And now its a crap shoot for the markets to untangle what the real risks areWhoa NellyIt is said that the camel is a what a horse would be it it were designed by a committee. If so then the FOMC statement is similarly a thoroughbred of statement operated on and genetically engineered by 17 different doctors.

Same old, same old, same old...Despite the fact that the Fed was doing its all too frequent communication via journalists after its last meeting and telling us market types that we must be crazy to think that the Fed would actually hike rates so soon with economic conditions as they are - in this meeting the Fed laid down that same warning again. I don't know why the Fed warns about risks to inflation and inflation expectations if it does not want us to get worried. Don't you cry WOLF to warn people of the danger, so they can be prepared? Didn't the Boy-Who-Cried-Wolf get punished for sending a false signal and scaring people unduly? And didn't that false warning come back to haunt him? What sort of warning is this: Wolf/never-mind? And what are the consequences? Jumpin' Jack flash, oh its just the gas...

The Fed spent time issuing these warnings then dumping on the market for building in a Fed rate hike after heeding them. Now, given the chance to amend this approach the Fed did not. Indeed, in the Fed's statement, it glommed onto any news of spending strength while shunting aside the preponderant news of weakness we have seen. Bad economic news has driven the stock market lower over the past three weeks (the DJIA is lower by 6% over these THREE weeks- HELLO? Anybody home there at the Fed???). Are the empty Fed governor chairs the ones assigned to market-watching? Apparently so. The Fed can only seem to remember back to the strong retail sales report while it low-balls the deteriorated labor market and other signs of economic erosion. Oh consumer confidence? That's gas! Maybe it is, but gas matters.

Too smart by one-three hundred and sixty fifthSo we are left to ponder if the Fed is leading us in this direction out of conviction? Is it getting us to think it sees conditions as robust so that we will view it as more likely to hike rates than to cut them? Or is is the Fed just saying that to get the same response? Do we really believe that after after all these weak numbers THIS is what the Fed thinks? Or it is this just what it could get a consenus on? Or...is this some odd variant of the mini-max strategy where you figure that the worst mistake would be to lead the market lower if rates should be higher so you try to lead them higher, regardless? Help needed from the VaticanObviously this job requires someone from the Vatican. The guy who has been trying to sort out how many angels can stand on the head of a pin is just the one for this job.

It's neither a breath mint nor a candy mint so spit it outIn the end it does not matter and that is what is so funny. The statement does not have to be digested and understood. It is neither truth nor fiction. Nor is it a communication device. The Fed will not act in a fashion contrary to the data. So watch the numbers and see. Where is the greater risk? Is the Fed right and is the economy firming? Or is it beginning to careen out of control as consumer budgets develop holes that make the gash in the side of the Titanic look small. Time will tell even if the Fed won't. And the Fed will do what it needs to do regardless of how people split hairs over what this statement really meant.

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About Me

Robert Brusca Ph.D. has been an economist on Wall Street since 1977. He has been a Division Chief at the NY Fed, a Fed-watcher at a major NY commercial bank and Chief Economist at major international securities firm. He is now an independent voice on the economy global trends and the political scene, operating a consulting firm in New York City. FAO Economics can be reached at 212-875-8637.